War-Time Financial Problems eBook

Such being the reason why this outburst of capitalisation
of reserves first began—­since in these
days all capitalists and those who have to manage
capital feel that they are working under criticism,
which is not only jealous and suspicious (as it should
be), but is also too often both ignorant and prejudiced—­it
is interesting to note that the movement which was
so started has been stimulated by its very exhilarating
effect on the market in the shares of the companies
concerned. Why this should be so it is difficult
at first sight to say. What happens is merely
this—­that a company, let us suppose, for
the sake of simplicity, with a capital consisting wholly
of 3,000,000 Ordinary shares, has accumulated out
of past profits, or out of premiums on new issues
of shares, a reserve fund of L1,000,000. Its
net profit has lately averaged L400,000, and it has,
year by year, distributed L300,000 in the shape of
a 10 per cent. dividend to its shareholders, and put
L100,000 into its reserve fund, which is represented
on the other side of the balance-sheet by buildings
and plant and a certain amount of first-class investments.
If the directors now decide to capitalise that L1,000,000
of reserve fund, the only effect is that each shareholder
will be given one new share for every three which
he holds in the existing capital, the reserve fund
will be wiped out, and the ordinary capital will be
increased from L3,000,000 to L4,000,000. None
of the shareholders will be in actual fact better
off to the extent of one halfpenny, because all will
be in the same position with regard to one another;
their relative shares in the enterprise will not have
been altered. If we imagine, by way of simplifying
the problem, that all the Ordinary shares were in
one hand, that one holder would have had in his Ordinary
shares a claim to the total assets of the company,
that is to say, to its earning power as long as it
is a going concern, and to whatever its assets realise
if it went into liquidation; the fact that L1,000,000
worth of the assets had been bought out of past profits
or premiums paid on new issues of shares would have
already added to the value of the claim that he had
on the property of the company, and no addition would
be made to that value by turning the reserve fund into
shares.

In other words, the reserve fund is already the property
of the shareholders, and to convert it from reserve
fund into capital, making them a present of new shares,
which merely represent their claim to the assets held
against the reserve fund, is as empty a gift as presenting
a man with a piece of paper informing him that he is
the owner of his own hat. All this remains equally
true if, besides the ordinary capital, there is a
considerable amount outstanding of Preference shares
and Debenture debt. In any case, the Ordinary
shareholders possess a claim to the earning power of
the company when prior charges have been satisfied,
and to whatever surplus may remain on liquidation